Trade Review: A Fed-Day Forex Trade

This trading case study provides useful insights on trading gaps and
fills on the charts, as well as shows the power of the Fed to move the markets
when interest rate decisions are announced.

As much as I like to write about current aspects of forex trading in my
articles, my favorite kind of lesson topics are when they deal with actual
events that have happened in the past because history always repeats itself.
Typically, the day-to-day actions of the markets present their own lesson in a
unique way, and we can learn much from these important occasions.

This week, I would like to take a look back at the Federal Open Market
Committee (FOMC) statement (Federal Reserve interest rate announcement) from
September. These news days typically cause plenty of commotion in the market,
and I usually have better things to do than try to get involved in trading the
news, as it can often be erratic and difficult to trade.

However, I do have exceptions to the rule, particularly when I am presented
with a unique trading opportunity that fits my trading plan. I choose to focus
my reasons for entering trades purely on the concepts of supply and demand. The
chart will always tell me what I need to know if I study it in a truly objective
fashion. In this case, let's take a look at the EUR/USD in recent trading
action:

Click to Enlarge

A few days before the FOMC statement, we can see that the EUR/USD was in a
consistent downtrend making lower highs and lower lows. In fact, the momentum
and sentiment was so strong that a gap down around 100 pips was created on the
September 19 opening.

However, gaps are two-fold in nature, as they can create very low-risk
trading set-ups, but they can also inhibit market price movement as well. You
see, I find it useful to think of a gap in any market as something like an
anomaly. It shouldn't really be there-like a spanner in the works or a blockage
in the pipes-and if it is left untreated, things will not be able to continue
working in the way they should.

In the case of the markets, we need to understand that a gap up is really
representative of an abundance of demand, and a gap down is really just formed
as a result of an overload of supply.

When imbalances are this strong, they create these huge levels where price
literally gaps down or up, but they are now vacuums of nothingness where price
never really traded. Much like the blockage in the pipes or an air bubble in
your heating system, the market is now unable to function correctly until the
anomaly or imbalance has been removed. This is what I call "bleeding the
system."

So, how would we apply this dynamic to the above example?

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Well, first, we should recognize that the gap down itself around the
1.3780-1.3810 area represents a pretty healthy, low-risk, high-reward trading
opportunity in a truly objective area where supply was undoubtedly greater than
demand.

It should also be noted that if we were looking to sell EUR/USD in this area,
we would also be going with the current downtrend which the market had been
exhibiting at the time.

With these two very simple and logical facts in place, we simply wait for
price to reach our entry area and take the trade as planned. This can be a
simple enough approach for some, but for others, it can be one of the most
challenging aspects of trading.

If we look at the above chart again, we can clearly identify the downtrend
and there can be a strong desire to enter the trade early, simply out of fear of
missing out on the trade, but we need to ignore this emotional way of thinking
and remember that from a logical point of view, this market will have a far
better chance of resuming its downtrend after it has corrected the anomaly
created by the supply gap.

Interestingly enough, the market failed to close this gap for a couple of
days after creating it and just drifted in a range-bound fashion, right up until
about five minutes before the big FOMC statement. When the actual news was
released, price spiked up into the supply area, filling the gap, and then
resumed its downtrend as normal.

Click to Enlarge

While it could have been seen as being a higher-risk trade because the entry
was triggered on the release of the FOMC statement, I have learned over the
years that even the biggest news releases will only push prices up or down to
the nearest quality level of support or resistance in a much shorter amount of
time. I am more concerned with finding the most objective levels to enter my
trades, rather than focusing on when they are triggered.

As it turned out, the FOMC statement that day proved to be something of a big
day for the markets fundamentally, with Ben Bernanke stating that he would be
buying $400 billion in Treasury securities in the longer-term range and
simultaneously selling an equal amount of short-term (three year or less)
securities by the end of June 2012.

The action was in light of his statement that there are "significant downside
risks to the economic outlook, including strains in the global financial
markets." Tell us something we didn't already know, Ben!

I hope this helps you find opportunities around future FOMC announcement
days.